💵 Why Saudi Ditches Dollar Deal

What’s on the Menu 🍴

We’ve got another exciting week ahead!

Let’s dive in:

• What To Watch This Week 👀

• Does The S&P 500 “Deserve” A Higher Valuation? 📈

• Why Saudi Ditches Dollar Deal 💵

Today’s newsletter is a 5 minute read.

What To Watch This Week 👀

Mega-cap tech stocks such as Apple and Nvidia continued their historic run higher last week, while many small & mid cap stocks declined despite lower bond yields.

Crypto also remained in a holding pattern.

Investors seem unsure about the bull market given signs of a softening economy, though there was some good news last week with a cooler than expected CPI inflation report.

This week could be a quieter one with relatively few earnings reports and a market holiday in the US on Wednesday, however there is a big options expiration day on Friday.

Speaking of options, Keith Gill (aka Roaring Kitty) sold all his Gamestop call options last week and invested some of the proceeds in more GME shares.

Meme stocks have been quiet, but the Gamestop annual meeting this week has the potential to provide some fireworks.

On the macro front we’ll be tuning into several Fed speaker speeches as well as the following:

• Reserve Bank of Australia rate decision (Mon)

• US retail sales (Tues)

• UK inflation (Wed)

• Bank of England rate decision (Thurs)

• US building permits (Thurs)

• Japan inflation (Thurs)

• UK retail sales (Fri)

• Germany manufacturing PMI (Fri)

Commodity prices stabilized last week but the mining and energy sectors have been laggards lately, so we’ll be watching for any reversals there this week.

We’ll also be keeping an eye on the following assets & sectors:

📈 Rising Recently:

• Semiconductors (SOXX / NVDA)

• Nasdaq-100 (QQQ)

• Government bonds (TLT / IEF)

📉 Falling Recently:

• Small Caps (IWM / IJR)

• Energy (XLE / XOP)

• Gold & Miners (GLD / GDX / GDXJ)

• Regional Banks (KRE)

• Airlines (JETS)

• Chinese stocks (KWEB / FXI)

Does The S&P 500 “Deserve”
A Higher Valuation? 📈

“Why should I invest in the stock market with such a high valuation?”

It’s a question many investors are finding asking themselves.

It feels like we haven’t been able to catch a break from high valuation multiples in the S&P 500 index for some time now.

So… let’s take it to the data to unpack what could be driving this trend.

First of all, the forward price to earnings ratio of the S&P 500 is sitting around 21x. This puts it above the 5-year average (19.2x) and above the 10-year average (17.8x).

The elevated valuation could be for a reason. It’s been trending above average for years now.

On the left side, you can see how the price to earnings ratio has trended. It’s particularly driven by the top 10 stocks in the S&P 500.

Part of the problem is these top 10 stocks have now become a larger percentage of the index (seen on the top right). People worry about concentration now of these stocks in the index.

Sounds risky, but, they’re pulling their weight in earnings contributions (bottom right).

So, while bifurcations creating concentration like this aren’t ideal, it’s the reality we are in.

Big tech companies are eating the world and driving a lot of the value that brings us to invest (I’m sure we’re all happy to have NVDA exposure, for example)!

Let’s take another look at why valuation on average has been higher: Profit margins.

Corporations have really learned how to get efficient (for the most part) and squeeze more profit out of revenues.

This trend is an investors friend. It helps grow earnings per share, which drives valuation!

Then, there’s cash.

Corporations have healthy amounts of it. Especially companies in the tech and communication services sectors.

More cash = less risk.

Investors like that. This is part of the reason a stock like Apple (AAPL) has been trading at a higher valuation (30x!) with low growth. It’s a safe haven with their 58 billion of net cash.

In addition to cash, S&P 500 growth companies are spending a lot of money on research and development and capital expenditures to improve their businesses. Their spend is above average while value companies are spending below average.

With this spend, it spurs (you guessed it): more revenue which leads to more profit if done well.

It’s just another notch on the belt of supporting WHY we’re paying up even at higher valuations on average (driven a lot by growth companies).

Of course, you can’t ignore the reliance on the top 10 companies driving performance and “safety”.

It means these companies really need to stay on top of their game. This is the risk.

However, we’ve seen corporations rise and fall over and over. Remember when IBM, AT&T and Exxon Mobile was all the rage and in the top 10 of the index?

Times change, and the cream always rises to the top. This is the beauty of investing in the index in the first place.

To wrap all of this up with a bow, there’s also forward earnings estimates that may be driving elevated valuation in the S&P 500 that we can’t escape.

Earnings growth isn’t stopping…for now.

When we look at what is expected for 2025, that would put us at a PE ratio today of roughly 19x. So, it could justify us NOT seeing a very deep correction going forward if all goes as planned.

Of course, there could be risks ahead that change the trajectory of businesses today.

Recession risks still exist alongside concerns over the labor market softening into persistent inflation. Higher credit card delinquencies are also showing their ugly teeth (particularly with younger generations).

However, there is plenty of data to explain why the S&P 500 keeps on trucking along and why it’s still a good time to invest.

Why Saudi Ditches Dollar Deal 💵

Saudi Arabia just dropped a bombshell that could shake up the global economy.

On June 9th, Prince Muhammad bin Salman decided not to renew the 50-year-old petrodollar agreement with the US.

This agreement, which started in 1974, has been a cornerstone of the dollar’s dominance. In exchange for US military protection, Saudi Arabia agreed to price its oil exclusively in dollars, cementing the greenback as the world's reserve currency.

But now, that deal is dead.

Here's the lowdown:

• The US dollar was backed by gold until 1971 when Nixon took it off the gold standard.

• This left the dollar vulnerable until the petrodollar deal with Saudi Arabia came along, making the dollar indispensable in global oil trade.

• Essentially, countries needed dollars to buy oil, leading to 80% of global oil trade being conducted in dollars.

• This not only propped up the dollar but also allowed the US to export its inflation by having surplus dollars invested back into US assets, a process known as petrodollar recycling.

So, what’s the big deal about Saudi Arabia pulling out now?

With the petrodollar agreement off the table, Saudi Arabia is free to sell oil in other currencies like the Chinese yuan, euros, yen, and even Bitcoin.

This move gives Saudi more flexibility and potentially better deals with other nations.

But for the US, it means losing a massive economic advantage. The end of this deal could lead to a flood of dollars returning to the US, triggering inflation like we’ve never seen before.

Why now?

The US-Saudi relationship has been rocky since President Biden took office.

His administration’s hard stance, including threats and attempts to revive the nuclear deal with Iran (Saudi’s arch-enemy), hasn’t helped.

Moreover, Saudi Arabia’s growing ties with BRICS nations (Brazil, Russia, India, China, and South Africa) are reshaping global economic alliances.

China and Russia have been moving away from the dollar for over a decade, and now with Saudi on board, this trend is accelerating.

What does this mean for us?

Well, less international demand for dollars could lead to higher inflation and lower global influence for the US. While the dollar won't lose its reserve status overnight, its dominance is waning.

This transition could take decades, similar to how the British pound slowly declined after the US dollar took over as the dominant currency post-World War II.

In a nutshell, Saudi Arabia ditching the dollar is a major pivot in global economics. It highlights the shifting power dynamics and the potential for increased volatility in currency markets.

As investors, we need to stay alert and perhaps rethink our strategies to navigate this new economic landscape.

Food For Thought 🧠

"The goal of a successful trader is to make the best trades. Money is secondary.”
- Alexander Elder

DISCLAIMER: We are not investment advisors, and this content is for educational purposes only. We don’t offer financial, legal, or tax advice. Nothing we say is a recommendation to buy or sell any assets. Trading and investing are extremely risky, so please be careful and do your own research.